India's Economic Woes Continue

The latest Indian economic data continues to paint a subdued picture. Third quarter GDP growth fell back to 5.3% year-on-year (YoY), the same level as in the first three months of the year, and lower than the 5.5% recorded in the second quarter. Despite this and the challenges of carrying out the necessary reforms, Indian markets ended November on a high.

Underlying this low (for India) figure, weak manufacturing expansion – at 0.8% YoY, and weak agricultural numbers – 1.2% YoY growth, were only partially offset by the main financial/business services sectors (Finance, Insurance, Real Estate and Business Services), which account for 55% of India’s total output, and grew by 9.4% on the previous year.

As covered previously on this blog, Indian monetary policy is facing a dilemma, with high inflation remaining a dangerous check on any attempt by the government to stimulate growth. Friday’s Consumer Price Index (CPI) for Industrial workers rose to 9.6% in October, up from 9.14% in September. Even as the Reserve Bank of India (RBI) faces this inflation/growth straitjacket, on the fiscal side a high budget deficit also constrains policy. India’s budget deficit is predicted to be 5.3% of GDP in the current year, slightly higher than the official target of 5.1%. The long term goal, announced by Finance Minister Palaniappan Chidambaram in late October, is for the deficit to hit 3% by 2017. This target does not sit well with any hopes for further fiscal stimulus to the economy.

As with the United States, the Indian current account deficit drags on growth and hinders the struggling economy. This year has already seen record monthly deficits recorded, even if the annual deficit is predicted to fall to U.S. $70.3 billion this year. Meanwhile the labor market remains sluggish, with the Financial Timesrecently highlighting labor market inflexibility in addition to a skills deficit as explanations of the phenomenon. Reforming labor laws will require much political capital, and with a looming election no later than 2014, the government is already expending excess political capital on other reforms in the country.

Much of the recent momentum for reform came as fears grew that ratings agencies were considering downgrading India’s sovereign debt, costing the country its prized “investment grade” designation, which would further disrupt the economy by making it more difficult for the country to borrow the funds needed to cover its deficits. Plans for privatization and changes to the tax system were reaffirmed to combat the budget deficit, but, as with other reforms, there will be both social and political resistance to dramatic change.

In one piece of good news, Moody’s rating agency did not change its “stable outlook” on India’s debt when it released a new outlook late last month. Indian markets also appeared optimistic, reaching a 19-month high even as the low growth numbers were announced. Whether or not such optimism about India’s prospects for 2013 is misplaced will be answered in time, but political pressures related to the necessary economic reforms still leave many with doubts.